Wednesday, June 13, 2012 – To Hedge or Not to Hedge – by Sinclair Noe

DOW – 77= 12,496
SPX – 9 = 1314
NAS – 24 = 2818
10 YR YLD -.06 = 1.60%
OIL – .86 = 84.03
GOLD + 7.80 = 1618.60
SILV -.11 = 28.96
PLAT + 11.00 = 1471.00

If I went before the Senate Banking Committee and told lies, you can bet they would throw me into the gray bar hotel and toss the key. Today, Jamie Dimon, the CEO of JPMorgan Chase went before the Senate Banking Committee and as he took his seat in the Senate hearing room a protestor yelled, “This man is a crook and he needs to go to jail.” And then Jamie Dimon started talking and proved the protestor’s point. 

During questioning, Dimon was asked if the Volcker rule would have prevented the trades that led to $2 billion in losses (give or take a few billion) at JPMorgan? Dimon answered: “I don’t know what the Volcker Rule is, it hasn’t been written yet.” 

The proposed rule, mandated by the Dodd-Frank legislation, was published in November in the Federal Register and opened for public comment. Financial regulators are now in the process of finalizing it. Jamie Dimon is a board member of the New York Federal Reserve and as such is charged with regulating banking activity in accord with legislation such as the Dodd-Frank reforms and the Volker Rule; as CEO of JPMorgan, Dimon must certainly be familiar with the Volker Rule which would dramatically alter the rules of trading for a major part of his company. Of course the other option is that Dimon is a complete and blithering idiot – maybe that’s what he tried to sell to the senators – or maybe it just shows his contempt for the intelligence of the politicians and the public at large.

So, would the Volker Rule have prevented the losses? A little later, Dimon said: “It may very well have stopped parts of what this portfolio morphed into.” I don’t know why he would say that, after all, he doesn’t know what the Volker Rule is. 

Then Dimon was trapped in another lie; he said the job of the CIO, the trading unit in London that made the bad trades, their job was to make modest amounts of money in good times and make a lot of money in times of crisis. This sounds like an admission that what Dimon has labeled as hedging actually had nothing to do with hedging, it was speculative trading. 

None of the senators took offense with Mr. Dimon’s lies. This is part of the problem. When someone achieves the position of CEO of JPMorgan Chase, we no longer require them to tell the truth in testimony before Congress; they no longer feel compelled to tell the truth; there is no penalty for dishonesty. Quite the contrary, Wall Street rewards dishonesty and creates a moral hazard. But today, the Jamie Dimon dog and pony show presented contrition and what might be considered remorse; and the Wall Street crowd tossed roses at the feet of their favored actor. JPMorgan shares gained .53 cents to 34.30, adding about $2 billion to the market cap. 

As for the politicians, they played their role upon the stage; note this exchange between Dimon and New Jersey Senator Bob Menendez: “Hedge or not a hedge, that’s the real question. Hedge doesn’t create a loss without a corresponding gain, that’s why you’re hedging. But you were selling a toxic instrument in CDS. When you hedge a hedge … isn’t that gambling?”

Dimon: “I don’t believe so, no.”

Menendez: “So this transaction that you said morphed, what did it morph into, Russian roulette?”

Dimon: “It morphed into something I just can’t justify, that was too risky for our company.” (notice that Dimon never answered what the transaction had morphed into)

Menendez: “And that is the real concern here. … If it’s too risky for your company, what stops it from being in the future too risky where you lose … $50 billion … that takes that bank into the possibility of a run and ultimately becomes the collective responsibility of each and every American? … I’m glad to hear you say … that we should ‘take comfort’ that banks are more collateralized. … Do you regret calling the efforts to get banks to hold more money ‘un-American’ and ‘putting the nail in our coffin’? … You railed against us when we were trying to pursue greater capitalization of these banks.”

Dimon: “I don’t think what you said is true. I supported parts of regulation and reform. I supported higher capital and higher liquidity. … We did not fight everything. When I mentioned the anti-American thing, I was talking about between Dodd-Frank and Basel things that were being skewed against American banks. …”

Wow. I didn’t realize it’s anti-American to expect banks to follow a few basic rules to prevent a meltdown of the global financial system, especially after having received hundreds of billions in taxpayer funded bailouts. I didn’t realize it was un-American to ask banks to hold just a small cushion in capital reserves, just in case something goes wrong; maybe they might need to access some of the capital which we allow them to print out of thin air. I’m not sure the conversation ever got to the point of addressing why Dimon felt it was acceptable to risk excess deposits, money that does not technically belong to JPMorgan. I suppose once you become inured to dishonesty it is such a small step to gambling with other people’s money. 

Credit ratings agency Moody’s Investors Service cut its rating on Spanish government debt on by three notches to Baa3 from A3, saying the newly approved euro zone plan to help Spain’s banks will increase the country’s debt burden.  Moody’s also said it could lower Spain’s rating further because of the Spanish government’s “very limited” access to international debt markets and the weakness of the national economy.  The rating is on review for possible further downgrades, which could come within the next three months.

The Federal Reserve released its triennial Survey of Consumer Finances. We are getting poorer. Deciphering the survey requires some ciphering and according to one calculation median net worth was close to levels not seen since the 1992 survey.

Median family net worth in 2010 dollars:

1989: $79,600
1992: $75,400
1995: $81,200
1998: $95,500
2001: $106,100
2004: $107,200
2007: $126,400
2010: $77,300

Net worth is a family’s assets, such as houses, cars, and stocks, minus its liabilities, such as mortgage debt. The median is the midpoint: Half of all families have net worth higher than the median, and half lower. Median family net worth rose 62 percent from 1962 to 1983, then fell 12 percent from 1983 to 2010. Since the methodology of the survey changed, those numbers are almost certainly off, nothing more than a decent guess. Still, if they’re anywhere close to reality, it’s more evidence of how the American economy has failed to generate rising living standards for most people in recent decades.

The major reason this recovery has been so anemic is we no longer have the money we used to have, and we can’t borrow like we used to, even if we wanted to. In 2010, over 35% of American families said they did not “have a good idea of what their income would be for the next year.” That’s up from 31.4% in 2007.

The proportion of families that said they had saved in the preceding year fell from 56.4% in 2007 to 52% in 2010, the lowest level since 1992.Median family income was $49,600 in 2007. By 2010 it was $45,800 – a drop of 7.7%. All of the gains from economic growth have been going to the richest 1 percent – who, because they’re so rich, spend no more than half what they take in. Even if you are uber-rich, there are limits to your buying; you won’t buy enough bath soap to compensate for the 99 other consumers that might buy soap, even if they are the great unwashed masses. 

The American economy is still struggling because the vast American middle class can’t spend more because they don’t have more to spend. This economics stuff is actually pretty simple. 

Tomorrow on the Financial Review our guest will be Christopher Hayes, author of the new book “Twilight of the Elites – America After Meritocracy”. Streaming audio and archives at moneyradio.com

– Sinclair Noe

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